ANALYSING The RISK AND RETURN OF INVESTMENTS

ANALYSING The RISK AND RETURN OF INVESTMENTS
Solutions
Multiple choice questions:
Question 1 (d)
Question 2 (d)
FV = PV(1 + i)n
= $40,000 (1 + (06./2)(4 x 2)
= $40,000 (1 + .03)8
= $50,671
Question 3 (a),
FV = PV(1 + i)n
= $12,000 (1 + (.085/2))(5.5 x 2)
= $12,000 (1+ .0425)11
= $18,967.80
$12000 – $18,967.80 = $6,967.80
Question 4 (b)

PV

=

FV (1 + i)n

= $40,000
(1+ ((.04/4)) (3×4)
= $40,000
1.126825
= $35,498
Question 5 (d)
FV = PV(1 + i)n
= $120,000 (1 + (.04/2))(14 x 2)
= $120,000 (1 + .02)28
= $208,923
Question 6 (b)
PV = C
PV = $100,000
PV = $100,000
PV = $100,000
PV = $100,000 ( 6.14457)
PV= $614,457
Question 7
Weighted average expected rate of return:
(10% x 8%) + (50% x 10%) + (40% x 15%) = .008 + .05 + .06 = 11.8%
Question 8
Whilst the statement that a higher standard deviation represents greater risk is true, the
higher risk is also likely to be associated with greater returns. The risk that an investor
will accept would depend on a number of factors including:

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-risk profile
-whether the investment is short term / long term
-need for access to liquidity
-whether there are any dependants
gross income / saving capacity
Question 9
(i) Range of returns

Company	E(R)	Standard Dev.	Range of returns 1 St. Deviations	Range of returns 2 St. Deviations
Financial	10%	15%	(5%) – 25%	(20%) – 40%
Guinness	12%	7%	5% – 19%	(2%) – 26%
Hattel	15%	13%	2% – 28%	(11%) – 41%

(ii)	For a risk averse investor, the investment with the least volatility would be preferred – ie Guinness

Question 10
With a 2/3 degree of certainty, we can expect the range of returns to lie within
plus/minus one standard deviation from the expected return.
8.5% + 3%. Answer is (d).
Question 11
(i) The principle of correlation is a measure of the way in which the returns of
two investments move in relation to each other. Positive correlation would
exist if the returns of the two assets tend to move in the same direction,
whereas negative correlation would be where the returns would move in
opposite directions.
To achieve effective diversification, assets should be selected on the basis of
exhibiting returns that move in opposite directions to each other.
(ii) Highest correlation: international shares/domestic shares & international
bonds/domestic bonds
Highest negative correlation: international bonds/shares

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